1. Field of the Invention
The present invention is directed generally to methods of evaluating the performance of a family of target date funds.
2. Description of the Related Art
The term “target date fund” refers to a relatively new kind of diversified mutual fund that is intended to maximize wealth generated by the fund as of a particular “target year” or “target date.” For most target date funds, the year portion of the target date is of greater importance than the month or day. Although, it is conceivable modifications to some target date funds may someday include finer gradations.
Because a target data fund is concerned with future wealth generated as of a particular date, fund providers typically offer a plurality of target date funds (referred to as a “suite” or “family”) each having a different target date. FIG. 1 provides an illustration of an exemplary Family “F1” including nine target date funds, TDF1-TDF9. Currently most, if not all, target date fund families offered by fund providers include target date funds having target dates that occur at regular intervals, such as every five years, every ten years, and the like. For example, the target date funds, TDF1, TDF2, TDF3, TDF4, TDF5, TDF6, TDF7, TDF8, and TDF9 have the following target dates: 2010; 2015; 2020; 2025; 2030; 2035; 2040; 2045; and 2050, respectively.
Each target date fund in the Family “F1,” has an accumulation phase and a deccumulation phase. During the accumulation phase, an investor in the target date fund contributes to the fund. Generally, an investor makes periodic (and hopefully regular) contributions into the fund. The accumulation phase ends on the target date. Generally, the accumulation phase of each of the target date funds within a family has the same duration (e.g., about 45 years). Therefore, the accumulation phase for each target date fund begins on a different start date. For example, the accumulation phase of the target date funds, TDF1, TDF2, TDF3, TDF4, TDF5, TDF6, TDF7, TDF8, and TDF9 begin in the following years: 1965, 1970, 1975, 1980, 1985, 1990, 1995, 2000, and 2005, respectively. As is apparent to those of ordinary skill in the art, the Family “F1” may have been created after the start dates of one or more of the target date funds TDF1-TDF9. The deccumulation phase begins on the target date and does not necessarily have a predetermined end date. During the deccumulation phase, the investor may divest from the fund, converting the investment back into cash. However, in some cases, the investor may choose to invest in the fund during the deccumulation phase. Further, the investor may choose to leave at least a portion of his/her investments made during the accumulation phase invested in the fund during at least a portion of the deccumulation phase.
Each target date fund includes a plurality of assets each belonging to an asset class (stocks, bonds, cash equivalents, etc.). During the accumulation phase, the amount of money invested in each of the asset classes is varied according to an investment strategy that dictates the portion of the fund invested in each of the asset classes. Generally, as the fund approaches its target date, the investment strategy shifts the portion of the assets in the fund belonging to each of the plurality of asset classes towards a more conservative mix. During the deccumulation phase, the amount of money invested in each of the asset classes may also be varied according to the investment strategy or may remain constant. As mentioned above, the Family “F1” may have been created after the start dates of one or more of the target date funds TDF1-TDF9. In such cases, no money was invested in any of the funds before the creation date of the family. However, for each fund TDF1-TDF9, the same time varying investment strategy is used to determine the portion of the fund invested in each of the asset classes.
A fund manager makes decisions related to asset allocation, diversification, and rebalancing over the accumulation and deccumulation phases of the target date fund. In other words, the fund manager selects appropriate asset classes, allocates among them, and devises what he considers to be the optimal investment strategy within each asset class.
Within a family (e.g., the Family “F1”), the money invested in each of the target date funds is allocated according to the same investment strategy. However, different families typically have different investment strategies. Over the duration of a particular investment strategy, the amount of money invested in each asset class varies. By adjusting the portion of the assets in the fund belonging to each of the plurality of asset classes, the target data fund attempts to maximize wealth generated by the fund by the target date.
An investor may select a particular target date fund within the target date fund Family “F1” in which to invest based on a major event in the investor's life, such as the start of the investor's retirement, start of college for a child, and the like. The investor typically selects the target date fund within the family having a target date that is closest to the major life event. For example, if in 2007, a 53-year old person were contemplating retirement at age 65, that person would likely have chosen to invest in the target date fund that has a target date closest to his/her retirement date, which was about 12 years into the future. Therefore, in Family “F1,” this person is likely to choose fund TDF3, which has a target date of 2020.
Target date funds can be helpful for investors who prefer to use a single investment to save for a particular investment goal or life event. Some investors think of target date funds as an investment vehicle with “cruise control.” Besides choosing the right fund (using the target date closest to the life event), the investor's only other real task is to contribute regularly to the fund chosen. The fund is responsible for using the already invested capital and the new periodic contributions to maximize wealth generated by the fund at target date.
Target date funds are usually marketed as a family. The name of each target date fund within the family typically includes its target date or target year. For example, target date funds may have names like “Portfolio 2015,” “Retirement Fund 2030,” “Target 2040,” “Lifecycle 2045,” and the like. As with most mutual funds, target date funds can be sold through a variety of distribution channels and using a variety of fee structures. Standard symbols such as “A,” “B,” etc. may be added to the end of the name of a particular target date fund to reflect a method of sale and/or fee structure.
Russell LifePoints is a real world example of a family of target date funds. The Russell LifePoints family includes the Russell LifePoints 2010, Russell LifePoints 2020, Russell LifePoints 2030, and so on. If the same 53-year old person mentioned above who was contemplating retirement in 2007 at age 65 decided to invest in a fund of the Russell LifePoints family, he/she would likely choose the Russell LifePoints 2020 fund because its target date is closest to the person's contemplated retirement date.
A target date fund typically invests in a set of underlying funds (or in some other proxy for an asset class or style) and the amount of the target date fund allocated to a particular underlying fund changes over the life of that target date fund. This rebalancing takes place periodically and may occur as often as daily or as infrequently as every few years depending on the investment strategy of the target date fund family.
Fund providers typically do not disclose their investment strategies to the public. However, a fund provider may at its own discretion disclose its investment strategy to a plan administrator. The investment strategy includes a glide path. The term “glide path” refers to the shape of a plot of the portion of the target date fund invested in equities over the duration of the accumulation phase. Because all of the funds within a family are allocated using the same investment strategy, the glide path for each fund is substantially identical. Therefore, the glide path may be described as a property of the family of target date funds as well as a property of the individual target date funds in the family.
For illustrative purposes, in FIG. 2, an example glide path 10 of a conventional target date fund family is shown. The y-axis shows the percentage of equity allocation (i.e., the amount of the fund invested in equity asset classes) within the target date fund. The x-axis illustrates the years of the accumulation and deccumulation phases of the target date fund. Year 0 is the target date. Year 45 is the beginning of the accumulation phase; therefore, Years 45 to 0 correspond to the accumulation phase and years 0 to +30 correspond to the deccumulation phase. As FIG. 2 illustrates, the equity allocation is highest at the beginning of the accumulation phase and continues to decrease over time. In other words, the “glide path” is downward sloping and shows a decrease in equity allocation occurring over time.
For an investor, such as a defined benefit plan sponsor, selecting among the increasing variety of new target date products is a formidable task. As mentioned above, fund providers typically do not disclose their investment strategies or glide paths to the public. While a hallmark of target date funds is their simplicity of use, their design is complex and there is no commonly accepted framework for designing them. Investors often hear compelling but different stories from asset management firms. Many times, even a plan's consultant struggles to understand the nuances in design of these new and rapidly evolving investment vehicles. While selection of an appropriate target date fund within a family is somewhat straight forward, the prior art includes no methods or tools for comparing target date fund families. Therefore, the prior art offers the investor no guidance whatsoever in selecting a target date fund family from which to select a target date fund.
One of the fundamental problems in selecting a target date fund family is the lack of an objective, returns-based measure of performance that is appropriate for evaluating target date funds. While investment decisions should never be based solely on past performance, any responsible fiduciary choosing among families of target date funds is going to ask the following questions: how have they performed; have they done better than some simple but reasonable benchmark; and how has a particular family of funds performed relative to its peers? The plan sponsor and/or investors may also want to know how to determine whether a particular target date fund has performed in accordance with representations made by investment managers.
Unfortunately, measures traditionally used to evaluate the performance of (non-target date) mutual funds are unsuitable for use with target date funds. To report performance, regular mutual fund performance measures use standardized, time-weighted portfolio returns over various periods such as one month, one year, etc. Similar regular mutual funds are grouped into similar strategy and/or style categories of a performance universe. A passive market index is sought that is most similar to a particular group of mutual funds being analyzed. The time-weighted portfolio returns for these regular mutual funds and the corresponding benchmarks are then reported for one more evaluation periods (e.g., one year, three years, five years, and ten years). An example of this traditional performance reporting is shown below in the Table 1.
TABLE 1Fund Performance Annualized Periods Ending Mar. 31, 20071-Year3-Years5-Years10-YearsRussell Equity I Fund10.28%11.58%7.55%8.27%Russell 1000 ® Index11.84%10.73%6.92%8.61%S&P 500 ® Index11.83%10.06%6.27%8.20%
This conventional analysis works well for regular single-asset-class mutual funds and regular multi-asset-class mutual funds that have static asset allocations. However, as described earlier, target date funds are managed to a target date and thus their allocations change over time.
Therefore, in a particular market condition, a selected target date fund may outperform a peer fund. However, the very same target date fund may or may not outperform the very same peer fund five or ten years in the future under identical market conditions because the underlying fund allocations would have changed over the five or ten years. For example, suppose for 2007, Fundco's 2020 fund had a higher one-year return than SaveMart's 2020 fund. Nevertheless, for 2012, Fundco's 2020 fund may have a lower one-year return than SaveMart's 2020 fund even if market conditions remained constant. Consequently, traditional performance measures fall short when applied to target date funds.
Additionally, while for 2007, Fundco's 2020 fund outperformed SaveMart's 2020 fund, SaveMart's 2040 fund may have outperformed Fundco's 2040 fund. Generally, a plan sponsor offers investors the target date family of Fundco or SaveMart and does not offer a selected target date fund from SaveMart and another target date fund from Fundco. Therefore, investing in Fundco's 2020 fund and SaveMart's 2040 fund may not be possible.
Analyzing target date funds on a fund-by-fund basis leads to arbitrary conclusions that are not helpful in making decisions. What should an investor do if Fund A has a good 2040 fund but a bad 2010 fund and, Fund B has a bad 2040 fund and a good 2010 fund? It is not practical to invest in Fund A's 2040 fund and Fund B's 2010 fund.
Knowing one fund outperformed another provides little or no useful information that may be used to evaluate the performance of a target date fund with respect to the goal of maximizing wealth at a target date. In other words, this information does not help an investor determine whether he/she will achieve, fall short, or exceed a target wealth goal on the target date. Therefore, knowing one fund outperformed another provides no practical actionable information to either investors or plan sponsors.
Determining how a family of target date funds has performed relative to a reasonable benchmark is problematic because selecting a benchmark is complicated by the fact that different target date funds in the family are likely to have different asset allocations on the same dates (as dictated by the investment strategy). Therefore, a passive benchmark for each fund would have to match the investment strategy of the fund.
One intuitively appealing idea to remedy this problem is to have “benchmark” target date fund having an asset allocation that is varied according to a benchmark investment strategy. While index providers have made efforts to create such a benchmark investment strategy, there is no obvious candidate for an industry standard. Each index provider, as well as each asset manager, uses different assumptions about contributions, asset class returns, goals, and risk aversion when constructing an investment strategy for a family of target date funds. There are also fundamental differences in methodology between investment strategies. Because there is no common industry consensus regarding investment strategy methodology and assumptions, there is little hope of having a benchmark investment strategy that is generally accepted.
A target date fund uses contributions invested over time to create wealth at the target date. Therefore, an effective performance measure of target date fund performance should incorporate contributions made to the funds. Because traditional time-weighted returns remove the effect of the timing of cash flows (e.g., contributions) by design, they are unsuitable for evaluating the ability of a target date fund to generate wealth by the target date. Specifically, time-weighted returns ignore the fact that returns in the final few years before the target date have much more impact on the retirement wealth of a typical investor than returns in the early years. Thus, an appropriate performance measure for a target date fund should give greater importance to returns nearer the target date.
Therefore, a need exists for a returns-based, objective measure of the performance of a family of target date funds. It is also desirable to have a measure of the performance of a family of target date funds that determines the propensity of the funds to build wealth. It would also be beneficial to identify an implementable benchmark portfolio that could function as an alternative strategy to investment in the family of target date funds. The present application provides these and other advantages as will be apparent from the following detailed description and accompanying figures.